Working Paper: NBER ID: w29160
Authors: Eduardo Dvila; Ansgar Walther
Abstract: This paper studies the optimal design of second-best corrective regulation, when some agents or activities cannot be perfectly regulated. We show that policy elasticities and Pigouvian wedges are sufficient statistics to characterize the marginal welfare impact of regulatory policies in a large class of environments. We show that the optimal second-best policy is determined by a subset of policy elasticities: leakage elasticities, and characterize the marginal value of relaxing regulatory constraints. We apply our results to scenarios with unregulated agents/activities and with uniform regulation across agents/activities. We illustrate our results in applications to shadow banking, scale-invariant regulation, asset substitution, and fire sales.
Keywords: corrective regulation; policy elasticities; pigouvian wedges; market failures; financial regulation
JEL Codes: D62; G18; G28; H21
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| policy elasticities (H30) | marginal welfare impact of regulatory policies (D69) |
| pigouvian wedges (H23) | marginal welfare impact of regulatory policies (D69) |
| optimal second-best policy (H21) | marginal welfare effects of varying regulatory instruments (D69) |
| policy elasticities (H30) | marginal welfare effects of regulatory instruments (D69) |
| pigouvian wedges (H23) | marginal welfare effects of regulatory instruments (D69) |
| relaxing regulatory constraints (G18) | marginal welfare effect (D69) |
| policy elasticities (H30) | adjustments for equilibrium responses (D50) |
| pigouvian wedges (H23) | adjustments for equilibrium responses (D50) |